Exchange-traded Funds 

Portfolio construction and ETFs

Portfolio construction and ETFs

The use of exchange-traded funds (ETFs) has expanded rapidly in recent years, with global ETF assets now topping US$5trn (£3.8trn), according to data from ETFGI.

And it is not just large institutional investors who have benefited from this growth. The rise of the ETF has been positive for investors of all sizes, bringing the advantages of low cost and broad diversification, and ultimately, better outcomes.

Low-cost ETFs are winning converts among investors who have traditionally favoured individual stocks and high-cost mutual funds. This suggests investors are increasingly recognising the negative impact of high fees on long-term returns.

Among advisers, access to ETFs through platforms in the UK remains a challenge, although this is improving and growing numbers of advisers are showing an interest in using ETFs to help clients build their portfolios, access a range of exposures at low cost, and reach their financial goals. 

Index funds have been a huge force for change in investing, helping people reach their goals more quickly by reducing their costs and allowing them to keep more of their returns.

ETFs represent the next stage of the indexing revolution globally, and they are increasingly becoming the vehicle of choice for investors’ index exposure. The EDHEC European ETF Survey 2017 suggests that 71 per cent of European investors use them frequently for achieving broad market exposure.

Key points

  • Low cost ETFs are becoming popular with investors
  • ETFs can be bought and sold on the stock exchange
  • ETFs can provide diversification

Many advisers are now discovering how the disruptive power of ETFs can benefit their clients. They can be accessed at any time across a range of exchanges by investors anywhere in the world, and they are effectively democratising investing by providing institutions, advisers, and retail investors with the same investment tools at the same costs.

What are ETFs and how can investors use them?

ETFs combine the features of mutual funds with those of individual shares.

Like a traditional mutual fund, an ETF offers the opportunity to invest in a portfolio of securities, such as stocks or bonds.

As with a mutual fund, each share of an ETF represents an undivided interest in the underlying assets. They also offer professional management, so you do not have to keep track of every security your fund owns.

 

However, ETFs are different in that they can be traded throughout the day on an exchange at a market-determined price. Mutual funds, in contrast, are bought and sold directly through the fund company at the fund's net asset value (NAV) at the end of each trading day.

Most ETFs use an indexing approach. They are built so that their value can be expected to move in line with the indices they seek to track. For example, a 2 per cent rise or fall in an index should result in approximately a 2 per cent rise or fall for an ETF that tracks that index (before fees and expenses).

ETFs offer a number of benefits, including low costs, liquidity, and diversification.

ETFs generally have lower ongoing charges figures (OCFs) than mutual funds, and index-based ETFs generally cost less than actively managed funds and ETFs. Lower costs mean more of a fund's returns go to the investor. However, when trading ETFs, investors incur transaction costs such as broker commissions, so investors should always weigh the full costs of investing.

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